Relative bond yields are both a cause and effect of real transaction flows. So is the level of a currency. As FX traders, we want to know whether money is going to flow to one currency over another, and also whether existing flows will be maintained at the same levels. The world’s savers generate a certain amount of investible cash every month, and it’s very much a zero-sum game as to who is going to be the beneficiary.

One way we keep score is the U.S. Treasury International Capital System after $63.1 billion in July (revised). Other revisions reduced the January- July cumulative by $17.3 billion. It’s a bit scary that foreign purchases of U.S. Treasuries were only $14.6 billion, down from $22.4 billion in July and $40.6 billion in June. Agency bonds (mostly Fannie Mae and Freddie Mac) were $21.2 billion, corporatebonds were $26.5 billion, and foreigners sold equities to the tune of $2.1 billion after becoming buyers of $9.8 billion in July and $1.8 billion in June. This was the fourth month in six foreigners were net sellers of U.S. equities. Meanwhile, U.S. investors were sellers of foreign equities and bought only a small amount of foreign bonds ($2.6 billion). If U.S. investors had been net buyers of foreign equities, the net inflow would have been even lower. The monthly average so far in 2004 is an inflow of $73.2 billion, compared to the monthly average of $58.2 billion in 2003 and $47.9 billion in 2002. Yearto date, 2004 has seen an inflow of $585.3 billion compared to $508.3 billion last year.

By country, Japan was a buyer of $27.4 billion (up from $12.3 billion in July), mostly in Treasuries more than half the total capital inflow for the month. China actually sold $800 million in Treasuries but bought $2.5 mil lion in Agencies, while Taiwan also sold $1.1 billion in Treasuries. Hong Kong, Singapore and South Korea were all small buyers. Counties that represent speculators rather than central banks — the Caymans and Bahamas — were still buyers, but in lesser amounts.

A smaller monthly number that still has a cushion is not cause for big alarm, but we also need to worry about the variability of the inflows. The monthly number varies from as high as $104 billion (May 2003) to as low as $6.2 billion (September 2003). We care about foreign inflows into the U.S. more than any other country because the U.S. current account deficit is the gorilla in the living room, generating a need for $50-55 billion per month just to balance the outflow of dollar cash in trade.

China made $5 billion from selling to the U.S. but didn’t turn around and reinvest in it in U.S. paper; China sold U.S. Treasuries and bought only $2.5 billion in Agencies — less than half its dollar earnings. At the September Treasury auction of 10-year notes, foreign central banks bought only 2.8 percent of the offering, after taking 38 percent and 54 percent of the two previous 10-year auctions. Foreign central banks were back in October, taking 32 percent, but their mysterious absence in September is a nagging worry.

Worrywarts fret foreigners will at some point consider they have as much U.S. paper as they want to hold. Fed and Treasury officials mention the potential exhaustion of foreign demand from time to time as a key background factor for dollar depreciation forecasts, although insisting t U.S. is not in imminent danger of a wholesale pullout. Well, no wonder.

The U.S. $23 trillion bond market is the biggest in the world by far. To some extent, the falling dollar the seed of bond market salvation. Bond traders have to offer cheaper prices/higher yields to get buyers to buy, which in turn provides dollar demand to the FX market. But as we know, a trend is a hard thing to shift once it gets going. Watch the relative bond yields for clues as to the persistence of the dollar downtrend and its possible end.